Capital Budget Evaluating Techniques
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Capital Budget Evaluating Techniques
Internal Rate of Return (IRR) is the rate that the present value of cash inflows equal cash outflows. This method helps determine the discount rate necessary for the present value of the discounted cash flows to be equal to the investment. It is used to compare a capital investment against other types of investments. This method is the most commonly used technique, but the net present value method is more accurate ("Three Primary Methods Used to Make Capital Budgeting Decisions", 2015).
The net present value (NPV) method determines whether an organization would be better off investing in a project based on the net amount of discounted cash flows for the project. The investment is considered profitable if the NPV is greater than zero. Due to inflation, money earned in the future is worth less in today's dollars than the same amount would be today. Therefore, NPV calculates all of the inflows and outflows over time, takes foreign exchange rates and inflation into account, and expresses the final benefit to the company in terms of today's dollars (Eldenburg & Wolcott, 2011).
The Payback Period technique determines the amount of time it will take to earn your initial investment back from the project. Typically, the shorter the payback period, the more attractive the project is to its business owners. The payback period does not make any assumptions of profit or return on investment. This method is outdated and is falling into disuse due to some significant drawbacks ("Three Primary Methods Used to Make Capital Budgeting Decisions", 2015).
References
Eldenburg, L.G., & Wolcott, S.K. (2011). Cost Management (2nd ed.). Retrieved from The University of Phoenix eBook Collection database.
Three Primary Methods Used to Make Capital Budgeting Decisions. (2015). Retrieved from http://smallbusiness.chron.com/three-primary-methods-used-make-capital-budgeting- decisions-11570.html
Internal Rate of Return (IRR) is the rate that the present value of cash inflows equal cash outflows. This method helps determine the discount rate necessary for the present value of the discounted cash flows to be equal to the investment. It is used to compare a capital investment against other types of investments. This method is the most commonly used technique, but the net present value method is more accurate ("Three Primary Methods Used to Make Capital Budgeting Decisions", 2015).
The net present value (NPV) method determines whether an organization would be better off investing in a project based on the net amount of discounted cash flows for the project. The investment is considered profitable if the NPV is greater than zero. Due to inflation, money earned in the future is worth less in today's dollars than the same amount would be today. Therefore, NPV calculates all of the inflows and outflows over time, takes foreign exchange rates and inflation into account, and expresses the final benefit to the company in terms of today's dollars (Eldenburg & Wolcott, 2011).
The Payback Period technique determines the amount of time it will take to earn your initial investment back from the project. Typically, the shorter the payback period, the more attractive the project is to its business owners. The payback period does not make any assumptions of profit or return on investment. This method is outdated and is falling into disuse due to some significant drawbacks ("Three Primary Methods Used to Make Capital Budgeting Decisions", 2015).
References
Eldenburg, L.G., & Wolcott, S.K. (2011). Cost Management (2nd ed.). Retrieved from The University of Phoenix eBook Collection database.
Three Primary Methods Used to Make Capital Budgeting Decisions. (2015). Retrieved from http://smallbusiness.chron.com/three-primary-methods-used-make-capital-budgeting- decisions-11570.html